Twinkies Maker Feels the Squeeze

Interstate Bakeries sees its sales fall as it struggles to keep up with rivals such as Krispy Kreme.

KANSAS CITY, Mo. — More than 70 years after the debut of the world-famous Hostess Twinkie, the current baker of the treats is struggling as competitors including Krispy Kreme Doughnuts Inc. eat away at the baked good industry's profits.

In July, Interstate Bakeries Inc., the nation's largest wholesale baker, reported its second consecutive quarterly loss. Company executives -- who had previously blamed the shortfalls on dwindling snack cake sales and higher expenses -- said they would no longer issue earnings guidance and refused to dismiss the possibility that they might stop paying a dividend to shareholders.

Analysts say the maker of such American classics as Twinkies and Wonder Bread has fallen behind in an increasingly competitive and costly business.

"I think they just need to make their products more contemporary," said analyst John McMillin of Prudential Equity Group Inc. "And that's obviously easier said than done."

Interstate Bakeries blames rivals for many of its woes. Chief Executive James Elsesser says selling doughnuts, Twinkies and Ding Dongs has become harder because of "the Krispy Kreme phenomenon" -- people are passing on Interstate Bakeries' sweets in favor of the doughnuts sold by the Winston-Salem, N.C.-based company, as well as other more gourmet-type products.

"Our cake business has lost both units and share as the Krispy Kreme phenomenon has affected the entire sweet goods industry," Elsesser said in a conference call with analysts in April.

But analysts say Interstate can't blame all of its problem on Krispy Kreme. Store shelves have become crowded with candy bars, energy bars and miniature cookies and chips -- and Interstate's product line lacks the pizazz and innovation to stand out.

"It used to be their only competition was Little Debbie. Now they've got a host of snack alternatives," McMillin said.

Interstate's bread business also has suffered. Mitch Pinheiro, an analyst with Janney Montgomery Scott, said Interstate failed to recognize yet another market trend: the premium and super premium breads that have become popular with adults. Although those breads cost only slightly more to make than ordinary bread, Pinheiro said, they sell for higher prices and are more profitable.

"They're behind the competition," Pinheiro said. "For the leading bread company in the country to have missed that trend is just inexcusable."

Company executives acknowledge the problems and say they're trying to find ways to fix them.

"The question is, how do we begin to sell products with greater appeal?" company spokesman Mark Dirkes said.

Interstate recently introduced two premium bread lines: Home Pride Country in the Midwest and Grandma Emilie's in the Northeast. The new products are designed to appeal to adults, particularly baby boomers, Dirkes said. The company's marquee product, Wonder Bread, is more popular with children.

Some old favorites also are getting makeovers.

The company is testing caramel-flavored Hostess Ho Hos in the Northeast. So far, those results are impressive, increasing Ho Ho sales in that area by nearly 50%, Dirkes said. But the company has yet to decide whether to sell the product nationwide.

"Overall, Ho Hos were already a pretty good seller," said Teresa Edington, a spokeswoman for West Bridgewater, Mass.-based Shaw's Supermarkets Inc., which is participating in the test. "Just having the extra product increased the sales."

Interstate also is looking at lowering prices and improving some of its packaging.

"Snack cake in particular is an impulse item," Elsesser told analysts July 14, "and we're trying to improve the odds that our product will be noticed and picked up."

Then there are the higher costs Interstate has faced in recent quarters. The price for health care, energy and ingredients has gone up for businesses in general.

As a result, the company is investing in technology that will allow it to know which routes and accounts are profitable. Interstate officials also are deciding whether to eliminate bakeries and thrift stores, and are weeding out some marginal products and consolidating some delivery routes.

"It's a very difficult environment out there," Elsesser said at the end of the July conference call, "and we have a lot of obstacles to overcome."